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Investors are no doubt familiar with the standard disclaimer, “past performance is not indicative of future results.” We know from working closely with individual investors for the past 20 years, however, that this compliance truism tends to stay in the fine print, both on paper and in investors’ minds, when they are making decisions based on real-time market dynamics.

Even if they purport to buy into the logic of the “random walk” argument about security prices, in practice, investors tend to extrapolate recent history into the future when making portfolio decisions—for example believing that if stock prices have gone up recently, they will continue on that upward trajectory. When the desire to chase returns goes unchecked, investors often engage in aggressive trading. But do they end up better off for their efforts?

To find out, the Gerstein Fisher Research Center examined the average investor’s actual returns in various asset classes versus the average performance of the asset class itself over the past 15 years (ending December 2010). The results were revealing, and confirmed our hypothesis that investors’ emotions can be their own worst enemy.

Sub-Par Results

Over the 15-year period we examined, the S&P 500 generated a (nominal) 6.66% annualized total return, while the average investor in mutual funds tracking the S&P 500 over the same period saw her portfolio’s value grow by only 1% in inflation-adjusted terms.

The table below shows how we arrived at this figure:

As seen above, the largest bite out of investors’ returns came from inflation, as measured by the annualized monthly Consumer Price Index data (Source: Bureau of Labor Statistics). The annualized expense ratio of 92 basis points was calculated as a weighted average using fund assets at the beginning of each year.

Control What You Can

While these key detractors from investors’ bottom-line performance are not entirely surprising, it is interesting to note the extent to which the outcome here is also driven by a factor over which investors, in principle, have complete control: their own behavior. Indeed, fully one percentage point of the investor’s underperformance relative to the index can be attributed to trading activity. Our research revealed this to be a strategy of essentially replacing recent underperformers with recent outperformers—in other words, attempting to time the market, and not doing a very good job of it. No wonder investment sage Warren Buffett, in a play on Sir Isaac Newton’s laws of motion, has said: “For investors as a whole, returns decrease as motion increases.”

Conclusion

Based on our research, it seems that by simply doing the opposite of what their instincts tell them to do, investors could earn an extra 100 basis points on an annualized basis—rather than losing it. Particularly when compounded over time, that’s real money.

To read the research paper “Past Performance is Indicative of Future Beliefs” by Philip Z. Maymin and Gregg S. Fisher, click here.